Research Explains Why the Obamacare Marketplace is Slowly Failing

With great fanfare, the U.S. Department of Health and Human Services issued a press release in mid-October estimating enrollment in the Obamacare Marketplace (i.e. the exchange) at 10 million by the end of 2016. HHS Secretary Burwell said, “We believe 10 million is a strong and realistic goal.”

Before you burst out with excitement, keep in mind enrollment for 2015 is estimated at 9.1 million. As recently as March 2015, estimates by the Congressional Budget Office (CBO) projected 21 million would sign up in 2016. Enrollment is only about half what the CBO originally estimated and is likely to gradually decline into what actuaries sometimes refer to as an adverse selection death spiral.

In a nutshell, Obamacare exchange plans are premised on the idea that young healthy people would be overcharged to help pay for older, less healthy enrollees – who would otherwise find their coverage unaffordable if charged premiums based on their health risk. In theory, sliding-scale subsidies would make premiums affordable for moderate-income families, while the law would force healthy, wealthier families to subsidize the poor and those in poor health. The only problem: people know when they are getting a bad deal and resist in any way they can!

This was tried once before in the 1990s. At the time, states passed perverse regulations to force insurers to accept all applicants — including people in poor health — at rates reflecting average health in a community rather than individual health status. What happened was young people (who already had lower demand for health insurance because they were healthy) were charged too much and abandoned the market. As healthy people dropped out, sicker people remained in the insurance market. As this progressed, the risk pool of enrollees that remained became increasingly costly to ensure. Premiums increased in response to higher costs of the remaining enrollees, prompting an new round of healthier enrollees to drop out.

Under these perverse incentives, the only enrollees who were sure to stay put were those in poor health — whose medical benefits far exceeded the cost of their premiums. This is what’s known as an adverse selection death spiral; it’s the vicious cycle of healthy individuals dropping out as their premiums rise too far beyond their expected benefits. Before long, health coverage is only a good deal for those in poor health. But, the customers in poor health are not profitable ones for health insurers. When insurers are left with money-losing customers, they have no choice but to increase rates even higher or leave the market entirely. That is precisely what happened in virtually all the states that passed these regulations. As a result, state lawmakers quickly repealed them in most states. In the states that retained these laws prior to Obamacare, premiums were between two and three times the average in states that didn’t retain these provisions.

If health insurance regulations that mandate community rating have a history of failure, then what made proponents believe the Obamacare Marketplace would survive? The answer: a combination of taxpayer subsidies and coercion! The Affordable Care Act exchange provision are often likened to a 3-legged stool. The three legs are: 1) a law forcing everyone to have coverage or pay a fine; 2) regulations that force insurers to sell plans to all that apply at prices adjusted age, but not for health status; and 3) generous, sliding-scale subsidies for those who are too poor to afford premiums. Removing any one of these legs upsets the applecart as my father used to say! The interaction of these three provisions was supposed to mitigate the tendency for healthy enrollees to balk when required to pay premiums far in excess of their expected benefits.

“Except for those who are heavily subsidized, Obamacare coverage is a really bad deal for the uninsured. Consider the poorest members on the Exchange (family income equivalent to 138-175% of poverty). Even after subsidies, the net premium paid by such families to obtain a Silver plan will be nearly triple the average amount they would have spent out of pocket had they remained uninsured!”

Health plans for the near-poor are highly subsidized, with their premiums capped at only about 3 percent to 4 percent of family income. Data shows that those are the ones most likely to enroll in Obamacare plans. Individuals receiving generous subsidies are about the only ones likely to consider costly exchange plans to be worth their (subsidized) premiums. By contrast, people who don’t qualify for subsidies are getting the proverbial shaft, and avoiding the exchange any way they can.

Consider the example of my wife and me. Neither one of us qualifies for a subsidy. We are both active, eat a healthy diet, watch our weight and try to lead a healthy lifestyle. The cheapest Obamacare policies for us are bronze plans costing about $5,000 apiece. These plans have deductibles of $6,000 or more. Our combined medical bills are probably less than $1,000 per year. Yet, we spend $10,000 on plans that provide us no benefits until we’ve spent another $12,000 out-of-pocket on medical care. Stated another way, our health plans will not begin to provide benefits until we have collectively spent more than $22,000 ($10,000 on premiums and $12,750 towards our deductibles). Think of it this way: this type of arrangement is only of value if we get hit by an (uninsured) bus, get advanced cancer, have a heart attack or experience a similar catastrophic health complaint. As you can imagine, the possibility of any of those things happen doesn’t make me lose sleep at night. And the possibility would probably not haunt my dreams if I were uninsured.

Writing in Forbes, Conover cautions this bad deal is expected to get worse as premiums rise (due to excessive regulations and probably a dollop of adverse selection). Conover points to research by Stephen Parente that estimates the premiums for bronze plans could double over the next year or so.

How will this play out? Here is what I predict: initially, moderate-income families are excited about getting coverage for a reduced rate. As time goes by, bills pile up, the car breaks down, the truck needs new tires, etc. Maybe an addition to the family is born, but daycare is now a burden. The couple calculates what their coverage is costing, say, $100, maybe $200 a month after subsidies. But their coverage has deductibles so high most doctor visits are paid out of pocket. They reason dropping their coverage will allow them to get caught up on some bills and they can enroll again at the next open enrollment. But at the next open enrollment, premiums are much higher than they anticipated. As this goes on, more and more people will decide the penalty is better than the cure.